HMRC on 19 June 2023 announced a consultation regarding potential reforms to three areas of UK international tax legislation: transfer pricing, permanent establishments and diverted profits tax (DPT).
Who does it apply to?
The proposed changes would apply to all businesses that fall within the scope of the UK’s transfer pricing, permanent establishments or DPT rules.
What is the aim of the consultation?
HMRC seek to clarify and modernise the relevant legislation, ensuring it achieves government objectives while developing simpler, more easily understood laws that support growth by improving tax certainty.
HMRC state that the reforms seek to:
- Improve fairness: ensuring multinational enterprises (MNEs) pay tax on profits generated from economic activity in the UK
- Simplify existing rules: aiming to develop simpler legislation that is easier to understand
- Support growth: improving tax certainty and continued access to treaty benefits, thereby promoting inward investment into the UK.
HMRC anticipate any changes to the rules to be tax neutral.
The government is considering changes to the law regarding pricing transactions between related parties and is proposing:
- Overhauling the concept of “provision” in the transfer pricing rules so that it more closely aligns to the related OCED model treaty concept of “conditions” between parties to a transaction
- Making the “one-way street” provision that ensures that transfer pricing adjustments only increase revenue collected in the UK easier to understand and apply
- For the transfer pricing connected parties rules, making the “participation condition” easier to apply
- For UK-to-UK transfer pricing rules, investigating whether these can be made easier to apply by introducing simple exemptions in specific situations
- Overhauling the treatment of loan guarantees in the context of transfer pricing of financial transactions.
The government is considering whether to amend the existing definition of permanent establishments and the profit attribution rules to better align with tax treaties and the OECD model treaty.
The proposed reforms could alter the basis for taxing UK activities of non-UK resident companies by changing the definition of a UK permanent establishment in one of two ways: aligning more closely with either tax treaty definitions or with the OECD model treaty. If the OECD model treaty approach is taken, this may involve adopting from the BEPS project the definitions of ‘dependent agent’ and ‘independent agent’. This is expected to include the OECD definition of a ‘person who habitually plays the principal role leading to the conclusion of contracts’ but excludes an independent agent who ‘acts exclusively or almost exclusively’ for related parties.
The consultation document specifies that the existing exemptions from PE status for UK brokers and investment managers would be maintained.
The consultation document also proposes updating the rules for attributing profits to permanent establishments to align them with the relevant double tax treaty or to the OECD model tax convention.
DPT is a freestanding anti-avoidance measure allowing HMRC to counter arrangements designed to divert profits from the UK. Proposals to update it include:
- Bringing it within the corporation tax rules so that it falls within the scope of double tax treaties and the relevant mutual agreement procedures in the future
- Changes to a number of the gateway tests to establish if a situation falls within the regime (eg the ‘effective tax mismatch outcome’ test and the ‘insufficient economic substance condition’ test) in the hope of simplifying the rules
- The punitive tax rates charged when DPT applies would be retained but the consultation considers whether the current upfront payment and lack of postponement of tax features should be removed, as they are not consistent with mainstream corporation tax.
Why is this important?
The consultation follows other developments in this area, such as the new UK legislation on mandatory transfer pricing documentation requirements introduced in April 2023. It follows record tax receipts from HMRC compliance activity in these areas (LINK).
While these reforms may take some time to finalise and implement, if they result in final legislation that achieves HMRC’s stated aims and the new framework corresponds more closely to current international principles and caselaw, that would be welcomed by many businesses. In particular, if updated rules were to provide greater certainty, assist in the settlement of mutual agreement procedures and enhance the attractiveness of the UK, then the reforms would likely be greeted enthusiastically. However, great care will be required to reach outcomes that achieve the stated objectives, given the complexity of the areas under discussion.
The consultation will close at 11:45 pm on 14 August 2023. In the lead-up to this deadline, HMRC is hosting several consultation events on these dates:
- 27 June (registration closes 23 June)
- 30 June (registration closes 26 June)
- 6 July (registration closes 29 June)
- 10 July (registration closes 29 June)
The BDO TP and International Tax team is currently reviewing the proposed reforms in detail and assessing their potential impact as some of these aspects may extend beyond simplification and clarification.
If you have any questions or would like to discuss these UK changes, please contact your BDO transfer pricing or International Tax specialist.
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